Strategic Financial Management · Forwards and Futures

Interest Rate and Currency Futures: Pricing and Hedging

Updated 11 October 2026 · Fact-checked

Interest rate and currency futures are exchange-traded contracts that fix a future interest rate or exchange rate today. To hedge, find your exposure, take the opposite position in futures (sell if you lose when the rate rises, buy if you lose when it falls), compute the number of contracts, then add the futures gain or loss to the spot outcome.

Understand Interest Rate and Currency Futures

A future is a standardised contract traded on an exchange. Two parties agree today on a price for an asset to be settled on a fixed future date. The exchange clearing house stands between them, so neither bears the other's credit risk. Both post margin, and gains and losses are settled every day (mark-to-market).

A currency future fixes the rate at which one currency is exchanged for another. In India, USD-INR futures are cash-settled in rupees, so no dollars change hands. The lot size is fixed by the exchange. In an exam, use the lot size given in the question. The fair futures price comes from interest rate parity: the currency with the higher interest rate trades at a forward premium.

An interest rate future is based on an interest rate or a notional bond. For short-term rate futures, the quote is 100 minus the rate. If the rate is 7%, the price is 93.00. A rise in rates pushes the price down. So a borrower who fears higher rates sells futures. A lender or investor who fears lower rates buys futures. For bond-based contracts, the price moves inversely with yield in the same way.

The hedge works because the futures gain or loss offsets the loss or gain on the underlying exposure. As the contract nears expiry, the futures price converges to the spot price. A perfect hedge locks in the original futures rate. In practice, basis risk (spot minus futures not behaving as expected), lot-size rounding and mismatched dates leave a small residual.

A forward rate agreement (FRA) and an interest rate future do the same job. The FRA is over-the-counter, customised in amount and date, carries bank credit risk and is settled once at maturity. The future is standardised, exchange-traded, margined and marked to market daily, with only standard amounts and dates available.

Key rules to remember

Currency futures fair price (discrete): F = S × (1 + r_d × t) ÷ (1 + r_f × t); S is the spot in domestic currency per unit of foreign currency. r_d is the domestic rate, r_f the foreign rate, t in years. Continuous form: F = S × e^((r_d − r_f) × t).
Interest rate future quote: Price = 100 − implied annual rate (%); Used for short-term rate futures. Rate up means price down.
Value of one tick (0.01) for a short-term rate future: Tick value = Contract size × 0.0001 × (contract months ÷ 12); A 3-month contract of ₹1,00,00,000 gives ₹250 per tick.
Number of currency futures contracts: N = Foreign currency exposure ÷ Lot size; Round to the nearest whole contract and state any unhedged amount.
Number of interest rate futures contracts: N = (Amount to hedge ÷ Contract size) × (Exposure months ÷ Contract months); Adjust the second ratio when your loan period differs from the contract period.
Duration-based hedge ratio (bond futures): N = (Modified duration of portfolio × Portfolio value) ÷ (Modified duration of futures × Futures contract value); Use when hedging a bond portfolio with bond futures.
Futures gain or loss: Long: (F_close − F_open) × quantity. Short: (F_open − F_close) × quantity; Net result = spot outcome + futures gain or − futures loss.
Basis: Basis = Spot price − Futures price; It falls to zero at expiry. If it does not, basis risk remains.

How to solve Interest Rate and Currency Futures questions

Use this order for any hedging question on interest rate or currency futures. It keeps the working clean and the recommendation clear.

1Identify the exposure: payable or receivable, borrowing or investment, the amount, and the date it falls due.
2Decide which move hurts you. An importer loses if the foreign currency rises. A borrower loses if rates rise.
3Take the opposite futures position. Buy futures to protect against a rise in the currency or a fall in rates. Sell futures to protect against a fall in the currency or a rise in rates.
4Compute the number of contracts using the lot size or contract size given. Adjust for the exposure period where needed.
5Work out the spot or actual outcome at the closing date under each scenario the question gives.
6Compute the futures gain or loss using the opening and closing futures prices. Assume convergence unless told otherwise.
7Combine the two to get the net cost or net receipt and the effective rate. Compare with the unhedged result.
8State a recommendation in one line, and note basis risk, margin cash flows and rounding.

Quickest way: Effective-rate shortcut for a perfect hedge

When to use it: Use when the question says to assume convergence and the exposure matches the contract amount and date. It also works to check your long working.

Work out the number of contracts and confirm the exposure is fully covered.
The effective rate is the opening futures rate (for currency) or the opening implied rate, 100 minus futures price (for interest rate futures).
Multiply that rate by the exposure to get the locked-in cost or receipt.
Still show one scenario in full, because examiners award marks for the gain or loss working.
Adjust only for unhedged amounts or basis changes that the question mentions.

Common mistakes in Interest Rate and Currency Futures

Taking the wrong side: buying futures when selling is needed, or the reverse.
Students memorise buy or sell for each case instead of asking which price move causes the loss.
Fix: Ask first what hurts you. If you lose when the price falls, buy futures. If you lose when it rises, sell futures. For rate futures, remember the price moves opposite to the rate.
Forgetting that rate futures are quoted as 100 minus the rate.
Students treat the quote as a rate or as a rupee price.
Fix: Convert the quote to a rate first (100 − 93.00 = 7%). Convert the closing price too, then measure the move in ticks of 0.01.
Ignoring the time factor in tick value, for example using the full annual 0.01% on a 3-month contract.
The annual rate is applied to the contract size without scaling for the contract months.
Fix: Tick value = size × 0.0001 × months ÷ 12. Use the same period for the loan interest when comparing.
Rounding the number of contracts wrongly or ignoring the leftover exposure.
Lot size is overlooked, or the answer is left as a fraction.
Fix: Divide the exposure by the lot size and round to a whole number. State any small amount left unhedged and that it is settled at spot.
Adding the futures gain to the cost instead of deducting it.
Students mix up cash outflow and inflow in the final line.
Fix: For a payable, net cost = spot payment − futures gain, or + futures loss. For a receivable, net receipt = spot receipt + futures gain, or − futures loss.
Using the wrong closing futures price instead of the spot, when convergence is assumed.
Students look for a separate closing futures quote that the question does not give.
Fix: On the expiry date, take the closing futures price equal to the closing spot unless the question gives a different closing futures price.

Worked examples

Example 1

An Indian importer must pay USD 5,00,000 in 3 months. Spot is ₹83.00 per USD. The 3-month USD-INR futures price is ₹83.60. One contract is USD 1,000. Show the result of hedging if the spot rate at maturity is (a) ₹84.50 or (b) ₹82.80. Assume the futures price converges to spot at expiry and ignore margin costs.

Show the solution

Exposure: USD payable. The importer loses if the USD becomes dearer, so buy USD futures.
Number of contracts = 5,00,000 ÷ 1,000 = 500 contracts bought at ₹83.60.
Case (a): spot ₹84.50, futures closes at ₹84.50. Futures gain = (84.50 − 83.60) × 5,00,000 = 0.90 × 5,00,000 = ₹4,50,000.
Spot payment = 84.50 × 5,00,000 = ₹4,22,50,000. Net cost = 4,22,50,000 − 4,50,000 = ₹4,18,00,000.
Case (b): spot ₹82.80, futures closes at ₹82.80. Futures loss = (83.60 − 82.80) × 5,00,000 = 0.80 × 5,00,000 = ₹4,00,000.
Spot payment = 82.80 × 5,00,000 = ₹4,14,00,000. Net cost = 4,14,00,000 + 4,00,000 = ₹4,18,00,000.
Effective rate in both cases = 4,18,00,000 ÷ 5,00,000 = ₹83.60 per USD.

Answer: Buy 500 USD-INR futures. The net cost is ₹4,18,00,000 (₹83.60 per USD) in both cases. The hedge removes the uncertainty but also removes the benefit of a fall in the dollar.

Example 2

A company will borrow ₹10,00,00,000 for 3 months, starting 3 months from now. The 3-month interest rate futures contract has a size of ₹1,00,00,000 and is quoted at 93.00. Show the hedge if the rate at the start of borrowing is 8.5% and the futures price closes at 91.50. Assume the borrowing is at exactly the market rate.

Show the solution

Exposure: borrowing later. The company loses if rates rise, which means the futures price falls, so sell futures.
Number of contracts = 10,00,00,000 ÷ 1,00,00,000 = 10. The loan period equals the contract period, so no further adjustment is needed.
Opening implied rate = 100 − 93.00 = 7%. Closing implied rate = 100 − 91.50 = 8.5%.
Price fall = 93.00 − 91.50 = 1.50 = 150 ticks of 0.01.
Tick value = 1,00,00,000 × 0.0001 × 3 ÷ 12 = ₹250. Gain per contract = 150 × 250 = ₹37,500.
Total futures gain = 10 × 37,500 = ₹3,75,000.
Interest at 8.5% = 10,00,00,000 × 0.085 × 3 ÷ 12 = ₹21,25,000. Net interest = 21,25,000 − 3,75,000 = ₹17,50,000.
Check: at 7%, interest = 10,00,00,000 × 0.07 × 3 ÷ 12 = ₹17,50,000. This matches.

Answer: Sell 10 futures contracts. The futures gain of ₹3,75,000 offsets the extra interest. The net interest cost is ₹17,50,000, an effective rate of 7% for the quarter, as locked in by the opening futures price.

Exam tips

Write the hedge position (buy or sell) and the reason in one line before any numbers. Examiners give marks for it.
Check lot size, contract size and contract months before computing. Most numerical slips come from these inputs.
If the question gives no closing futures price, say you assume convergence to spot. Show at least one full scenario, not only the shortcut.
For MCQs, test direction first: borrower or importer fearing a rise usually means selling rate futures and buying currency futures. Check the case before accepting this.
In theory answers, compare FRA and futures on market, customisation, credit risk, margin and settlement. Add a line on basis risk.

Practice questions from Forwards and Futures

Interest Rate and Currency Futures in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Interest Rate and Currency Futures: frequently asked questions

How do I hedge forex exposure using futures in India?

Work out whether you pay or receive foreign currency. An importer with a dollar payable buys USD-INR futures. An exporter with a dollar receivable sells them. Divide the exposure by the lot size to get the number of contracts. The contract is cash-settled in rupees on the exchange.

What is the difference between an FRA and an interest rate future?

An FRA is an over-the-counter contract with a bank, customised in amount and date, with credit risk and one settlement at maturity. An interest rate future is exchange-traded, standardised, margined and marked to market daily. Futures cannot be tailored, so a small mismatch with your exposure often remains.

Why does the interest rate future price fall when rates rise?

The quote is 100 minus the implied rate for short-term contracts. When the rate goes up, the quote goes down. For bond futures, prices fall because bond prices fall when yields rise. That is why borrowers sell rate futures to hedge.

Does a futures hedge guarantee the exact rate?

Only when the exposure matches the contract in amount and date and the futures price converges to spot at expiry. In practice, basis risk, lot-size rounding and daily margin flows create small differences. State these in your answer.